Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (all tabular amounts in thousands except per share amounts)
The following discussion includes a comparison of our Results of Operations and Liquidity and Capital Resources for the fiscal years ended October 31, 2020 (fiscal 2020), the fiscal year ended November 2, 2019 (fiscal 2019) and the fiscal year ended November 3, 2018 (fiscal 2018). Our fiscal year is the 52-week or 53-week period ending on the Saturday closest to the last day in October. Fiscal 2020 and fiscal 2019 were 52-week fiscal periods, while fiscal 2018 was a 53-week period. The additional week in fiscal 2018 was included in the first quarter ended February 3, 2018. Therefore, fiscal 2018 included an additional week of operations as compared to fiscal 2020 and fiscal 2019.
Impact of COVID-19 on our Business
The pandemic caused by the novel strain of the coronavirus (COVID-19) has resulted in government authorities implementing numerous measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter in place orders and shutdowns. These measures have impacted and likely will continue to impact our workforce and operations, the operations of our customers and those of our respective vendors and suppliers. We have significant operations worldwide, including in the United States, the Philippines, Ireland, Singapore, Malaysia, China and India. Each of these countries has been affected by the pandemic and taken measures to try to contain it, resulting in disruptions at some of our manufacturing operations and facilities. Since the beginning of the third quarter of fiscal 2020, our manufacturing operations and supply chain generally stabilized at normal levels, but that could change in the future given that the COVID-19 situation remains dynamic.
The spread of COVID-19 has caused us to modify our business practices (including restricting employee travel, modifying employee work locations and cancelling physical participation in meetings, events and conferences) and we may take further actions as may be required by government authorities or that we determine are in the best interests of our employees, customers, partners, suppliers and shareholders.
While we are confident that our strategy and long-term contingency planning have positioned us well to weather the current uncertainty, we cannot at this time fully quantify or forecast the impact of COVID-19 on our business. The degree to which COVID-19 impacts our business, financial condition and results of operations will depend on future developments, which are highly uncertain, and we cannot provide assurance as to the duration and spread of the pandemic, its severity, the actions to contain the virus or treat its impact, or how quickly and to what extent normal economic and operating conditions can resume.
Proposed Acquisition of Maxim Integrated Products, Inc.
On July 12, 2020, we entered into a definitive agreement (the Merger Agreement) to acquire Maxim Integrated Products, Inc. (Maxim), an independent manufacturer of innovative analog and mixed-signal products and technologies. Under the terms of the Merger Agreement, Maxim stockholders will receive, for each outstanding share of Maxim common stock, 0.630 of a share of our common stock. The estimated merger consideration is approximately $23.0 billion based on the closing price of our common stock on November 20, 2020. Following the recent approval of Maxim stockholders and our shareholders, as well as the expiration of the waiting-period applicable to U.S. regulatory approval, the transaction is subject to customary closing conditions, including receipt of certain non-U.S. regulatory approvals. See Note 6, Acquisitions , of the Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K for further information.
Results of Operations
A discussion of changes in our results of operations from fiscal 2018 to fiscal 2019 has been omitted from this Form 10-K, but may be found in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Form 10-K for fiscal 2019 filed with the Securities and Exchange Commission on November 26, 2019.
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Overview
Fiscal Year 2020 over 2019 2019 over 2018
2020 2019
2018 (1)
$ Change % Change $ Change % Change
Revenue $ 5,603,056 $ 5,991,065 $ 6,224,689 $ (388,009) (6) % $ (233,624) (4) %
Gross margin % 65.9 % 67.0 % 68.3 %
Net income $ 1,220,761 $ 1,363,011 $ 1,506,980 $ (142,250) (10) % $ (143,969) (10) %
Net income as a % of revenue 21.8 % 22.8 % 24.2 %
Diluted EPS $ 3.28 $ 3.65 $ 4.00 $ (0.37) (10) % $ (0.35) (9) %
_______________________________________
(1) Balances have been restated to reflect the adoption of Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (ASU 2014-09). See Note 2a, Principles of Consolidation , of the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K.
Revenue Trends by End Market
The following table summarizes revenue by end market. The categorization of revenue by end market is determined using a variety of data points including the technical characteristics of the product, the “sold to” customer information, the "ship to" customer information and the end customer product or application into which our product will be incorporated. As data systems for capturing and tracking this data and our methodology evolve and improve, the categorization of products by end market can vary over time. When this occurs, we reclassify revenue by end market for prior periods. Such reclassifications typically do not materially change the sizing of, or the underlying trends of results within, each end market.
2020 2019 2018 (1)
Revenue % of
Total
Product
Revenue (2) Y/Y% Revenue % of
Total
Product
Revenue (2) Y/Y% Revenue % of
Total
Product
Revenue (2)
Industrial $ 2,987,542 53 % (1) % $ 3,011,411 50 % (4) % $ 3,143,566 51 %
Communications 1,195,946 21 % (8) % 1,294,960 22 % 12 % 1,155,826 19 %
Automotive 779,276 14 % (16) % 930,613 16 % (8) % 1,006,886 16 %
Consumer 640,292 11 % (15) % 754,081 13 % (18) % 918,411 15 %
Total Revenue $ 5,603,056 100 % (6) % $ 5,991,065 100 % (4) % $ 6,224,689 100 %
_______________________________________
(1) Balances have been restated to reflect the adoption of ASU 2014-09. See Note 2a, Principles of Consolidation , of the Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K.
(2) The su m of the individual percentages may not equal the total due to rounding.
Revenue decreased across all end markets in fiscal 2020 as compared to fiscal 2019. The revenue decreases in the Automotive end market were more pronounced as this market was impacted by lower vehicle sales and a global slowdown in production as many of our customers were required to suspend their operations in response to shelter in place orders from governments around the world in response to the COVID-19 pandemic. The revenue decreases in the Consumer end market resulted from a broad-based decrease in demand for our products in this end market, including lower demand for products used in portable consumer applications. The decline in the Communications end market was primarily the result of the timing of infrastructure deployment cycles and the ramp up of these cycles in certain regions during fiscal 2019. The percentage decline in our Industrial end market was less than the overall percentage decline in total revenue as the broad-based weakness across many applications was offset by growth in the instrumentation test, healthcare and energy sectors of this end market.
Revenue by Sales Channel
The following tables summarize revenue by sales channel. We sell our products globally through a direct sales force, third party distributors, independent sales representatives and via our website. Distributors are customers that buy products with the intention of reselling them. Direct customers are non-distributor customers and consist primarily of original equipment manufacturers (OEMs). Other customers include the U.S. government, government prime contractors and certain commercial customers for which revenue is recorded over time.
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2020 2019 2018 (1)
Revenue % of
Total
Revenue (2) Revenue % of
Total
Revenue (2) Revenue % of
Total
Revenue (2)
Distributors $ 3,216,302 57 % $ 3,409,161 57 % $ 3,424,145 55 %
Direct customers 2,300,493 41 % 2,506,065 42 % 2,721,885 44 %
Other 86,261 2 % 75,839 1 % 78,659 1 %
Total Revenue $ 5,603,056 100 % $ 5,991,065 100 % $ 6,224,689 100 %
_______________________________________
(1) Balances have been restated to reflect the adoption of ASU 2014-09. See Note 2a, Principles of Consolidation , of the Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K.
(2) The sum of the individual percentages may not equal the total due to rounding.
As indicated in the above table, the percentage of total revenue sold via each sales channel has remained relatively consistent in fiscal 2020, fiscal 2019 and fiscal 2018.
Revenue Trends by Geographic Region
Revenue by geographic region, based upon the geographic location of the distributors or OEMs who purchased the Company's products, for fiscal 2020, fiscal 2019 and fiscal 2018 was as follows:
Change
Fiscal Year 2020 over 2019 2019 over 2018
2020 2019 2018 (1) $ Change % Change (2) $ Change % Change (2)
United States $ 1,887,443 $ 2,020,886 $ 2,277,084 $ (133,443) (7) % $ (256,198) (11) %
Rest of North and South America 41,250 55,059 46,276 (13,809) (25) % 8,783 19 %
Europe 1,245,695 1,374,673 1,405,686 (128,978) (9) % (31,013) (2) %
Japan 521,720 657,632 714,846 (135,912) (21) % (57,214) (8) %
China 1,348,011 1,316,275 1,215,949 31,736 2 % 100,326 8 %
Rest of Asia 558,937 566,540 564,848 (7,603) (1) % 1,692 — %
Total Revenue $ 5,603,056 $ 5,991,065 $ 6,224,689 $ (388,009) (6) % $ (233,624) (4) %
_______________________________________
(1) Balances have been restated to reflect the adoption of ASU 2014-09. See Note 2a, Principles of Consolidation , of the Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K.
(2) The sum of the individual percentages may not equal the total due to rounding.
In all periods presented, the predominant countries comprising “Rest of North and South America” are Canada and Mexico; the predominant countries comprising “Europe” are Germany, Sweden, and the Netherlands; and the predominant countries comprising “Rest of Asia” are Taiwan, Malaysia, South Korea and Singapore.
Total revenue decreased in fiscal 2020 as compared to fiscal 2019. However, revenue in China increased in fiscal 2020 as compared to fiscal 2019 as a result of the region's relatively quick recovery from COVID-19 related shutdowns as compared to other regions, as well as increases in demand across our broad market customers and stable revenue in the Communications end market attributable to the 5G ramp up.
The sales decrease in the United States year-over-year in fiscal 2020 was most pronounced in the Consumer end market. The sales decrease in Europe year-over-year in fiscal 2020 was primarily driven by products sold into the Automotive and Industrial end markets, while demand for products sold into the Communications end market was relatively flat. The sales decrease in Japan year-over-year in fiscal 2020 was broad-based as all end markets decreased from fiscal 2019. The sales decrease in Rest of Asia year-over-year in fiscal 2020 was primarily related to a decrease in our Communications revenue.
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Gross Margin
Change
Fiscal Year 2020 over 2019 2019 over 2018
2020 2019 2018 (1) $ Change % Change $ Change % Change
Gross margin $ 3,690,478 $ 4,013,750 $ 4,250,396 $ (323,272) (8) % $ (236,646) (6) %
Gross margin % 65.9 % 67.0 % 68.3 %
_______________________________________
(1) Balances have been restated to reflect the adoption of ASU 2014-09. See Note 2a, Principles of Consolidation , of the Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K.
Gross margin percentage in fiscal 2020 decreased by 110 basis points compared to fiscal 2019, primarily as a result of lower internal utilization of our factories due to decreased customer demand and temporary shutdowns at some of our manufacturing locations in response to the COVID-19 pandemic, partially offset by a write-down of inventory in fiscal 2019, which did not repeat in fiscal 2020.
Research and Development (R&D)
Change
Fiscal Year 2020 over 2019 2019 over 2018
2020 2019 2018 $ Change % Change $ Change % Change
R&D expenses $ 1,050,519 $ 1,130,348 $ 1,165,047 $ (79,829) (7) % $ (34,699) (3) %
R&D expenses as a % of revenue 18.7 % 18.9 % 18.7 %
R&D expenses decreased in fiscal 2020 as compared to fiscal 2019 primarily as a result of lower discretionary spending, partially in response to uncertainty associated with the COVID-19 pandemic, as well as lower R&D employee-related salary and benefit expenses and lower variable compensation expense.
R&D expenses as a percentage of revenue will fluctuate from year-to-year depending on the amount of revenue and the success of new product development efforts, which we view as critical to our future growth. We expect to continue the development of innovative technologies and processes for new products. We believe that a continued commitment to R&D is essential to maintain product leadership with our existing products as well as to provide innovative new product offerings, and therefore, we expect to continue to make significant R&D investments in the future.
Selling, Marketing, General and Administrative (SMG&A)
Change
Fiscal Year 2020 over 2019 2019 over 2018
2020 2019 2018 $ Change % Change $ Change % Change
SMG&A expenses $ 659,923 $ 648,094 $ 695,540 $ 11,829 2 % $ (47,446) (7) %
SMG&A expenses as a % of revenue 11.8 % 10.8 % 11.2 %
SMG&A expenses increased in fiscal 2020 as compared to fiscal 2019, primarily as a result of a $40.0 million charitable contribution to the Analog Devices Foundation made in the first quarter of fiscal 2020 and $20.1 million in acquisition-related transaction costs in connection with the proposed acquisition of Maxim, partially offset by lower discretionary spending in response to uncertainty associated with the COVID-19 pandemic, lower SMG&A employee-related salary and benefit expense and lower variable compensation expense.
Special Charges
We monitor global macroeconomic conditions on an ongoing basis and continue to assess opportunities for improved operational effectiveness and efficiency, as well as a better alignment of expenses with revenues. As a result of these assessments, we have undertaken various restructuring actions over the past several years.
Repositioning Actions: As a result of organizational initiatives to better align our global workforce with our long-term strategic plan, we recorded special charges of $49.4 million in fiscal 2020. The repositioning actions taken in fiscal 2020 are not expected to result in any future net annualized savings as the reduction in salary and benefits from workforce reductions will be redeployed to other areas of the business as part of the reorganizational initiative.
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Closure of Manufacturing Facilities: As a result of our decision to consolidate certain wafer and test facility operations acquired as part of the acquisition of Linear Technology Corporation (Linear), we recorded special charges of $2.9 million in fiscal 2020. Once fully implemented, we expect that these actions will result in estimated annual salary, variable compensation and employee benefit savings of approximately $60.0 million.
Operating Income
Change
Fiscal Year 2020 over 2019 2019 over 2018
2020 2019 2018 (1) $ Change % Change $ Change % Change
Operating income $ 1,498,244 $ 1,710,608 $ 1,899,589 $ (212,364) (12) % $ (188,981) (10) %
Operating income as a % of revenue 26.7 % 28.6 % 30.5 %
_______________________________________
(1) Balances have been restated to reflect the adoption of ASU 2014-09. See Note 2a, Principles of Consolidation , of the Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K.
The decrease in operating income in fiscal 2020 as compared to fiscal 2019 was primarily the result of a $323.3 million decrease in gross margin and an $11.8 million increase in SMG&A expenses, partially offset by a $79.8 million decrease in R&D expenses and a $43.3 million decrease in special charges as more fully described above under the headings Gross Margin, Selling, Marketing, General and Administrative (SMG&A), Research and Development (R&D) and Special Charges .
Nonoperating (Income) Expense
Change
Fiscal Year 2020 over 2019 2019 over 2018
2020 2019 2018 $ Change $ Change
Total Nonoperating expense $ 186,627 $ 224,880 $ 244,275 $ (38,253) $ (19,395)
The year-over-year decrease in nonoperating expense in fiscal 2020 as compared to fiscal 2019 was primarily the result of a decrease in interest expense related to our debt obligations.
Provision for Income Taxes
Change
Fiscal Year 2020 over 2019 2019 over 2018
2020 2019 2018 (1) $ Change % Change $ Change % Change
Provision for income taxes $ 90,856 $ 122,717 $ 148,334 $ (31,861) (26) % $ (25,617) (17) %
Effective income tax rate 6.9 % 8.3 % 9.0 %
_______________________________________
(1) Balances have been restated to reflect the adoption of ASU 2014-09. See Note 2a, Principles of Consolidation , of the Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K.
Our effective tax rates for fiscal 2020 and fiscal 2019 were below the U.S. statutory rate of 21% due to lower statutory tax rates applicable to our operations in the foreign jurisdictions in which we earn income. For fiscal 2020, our pretax income was primarily generated in Ireland at a tax rate of 12.5%. For fiscal 2019, our pretax income was primarily generated in Ireland and Singapore, at tax rates ranging from 12.5% to 17% in these jurisdictions.
Our tax rate for fiscal 2020 was also impacted by discrete items, primarily related to $25.9 million of income tax benefits resulting from the resolution of the Internal Revenue Service audit of Linear’s pre-acquisition federal income tax returns for fiscal 2015 through fiscal 2017, as well as other income tax benefits recorded upon the filing of our fiscal 2019 federal income tax return and excess tax benefits from stock-based compensation payments of $16.2 million.
The tax rate for fiscal 2019 includes a $17.2 million tax benefit from a voluntary accounting policy change in the statutory statements of a foreign subsidiary, an $11.2 million tax benefit from an increase in tax credits upon filing our fiscal 2018 federal income tax return and excess tax benefits from stock-based compensation payments of $28.7 million.
See Note 12, Income Taxes , of the Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K for further discussion.
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Net Income
Change
Fiscal Year 2020 over 2019 2019 over 2018
2020 2019 2018 (1) $ Change % Change $ Change % Change
Net income $ 1,220,761 $ 1,363,011 $ 1,506,980 $ (142,250) (10) % $ (143,969) (10) %
Net income, as a % of revenue 21.8 % 22.8 % 24.2 %
Diluted EPS $ 3.28 $ 3.65 $ 4.00 $ (0.37) (10) % $ (0.35) (9) %
_______________________________________
(1) Balances have been restated to reflect the adoption of ASU 2014-09. See Note 2a, Principles of Consolidation , of the Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K.
The decrease in net income in fiscal 2020 as compared to fiscal 2019 was a result of a $212.4 million decrease in operating income, partially offset by a $38.3 million decrease in nonoperating expense and a $31.9 million decrease in provision for income taxes, as more fully described above under the headings Operating Income , Nonoperating (Income) Expense and Provision for Income Taxes .
Liquidity and Capital Resources
At October 31, 2020, our principal source of liquidity was $1,055.9 million of cash and cash equivalents, of which approximately $241.9 million was held in the United States and the balance of our cash and cash equivalents was held outside the United States in various foreign subsidiaries. We manage our worldwide cash requirements by, among other things, reviewing available funds held by our foreign subsidiaries and the cost effectiveness by which those funds can be accessed in the United States. We do not expect current regulatory restrictions or taxes on repatriation to have a material adverse effect on our overall liquidity, financial condition or results of operations. Our cash and cash equivalents consist of highly liquid investments with maturities of three months or less, including money market funds. We maintain these balances with high credit quality counterparties, continually monitor the amount of credit exposure to any one issuer and diversify our investments in order to minimize our credit risk.
We believe that our existing sources of liquidity and cash expected to be generated from future operations, together with existing and anticipated available long-term financing, will be sufficient to fund operations, capital expenditures, research and development efforts, transaction costs associated with our proposed acquisition of Maxim and dividend payments (if any) in the immediate future and for at least the next twelve months.
Fiscal Year
2020 2019 2018 (1)
Net cash provided by operating activities $ 2,008,487 $ 2,253,100 $ 2,442,361
Net cash provided by operating activities as a % of revenue 35.8 % 37.6 % 39.2 %
Net cash used for investing activities $ (180,523) $ (293,186) $ (313,998)
Net cash used for financing activities $ (1,420,608) $ (2,126,794) $ (2,358,042)
_______________________________________
(1) Balances have been restated to reflect the adoption of ASU 2014-09. See Note 2a, Principles of Consolidation , of the Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K.
The following changes contributed to the net change in cash and cash equivalents from fiscal 2019 to fiscal 2020. A discussion of changes in our liquidity and capital resources from fiscal 2018 to fiscal 2019 has been omitted from this Form 10-K, but may be found in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Form 10-K for fiscal 2019 filed with the Securities and Exchange Commission on November 26, 2019.
Operating Activities
Cash provided by operating activities is net income adjusted for certain non-cash items and changes in assets and liabilities. The decrease in cash provided by operating activities during fiscal 2020 as compared to fiscal 2019 was primarily a result of lower net income, adjusted for non-cash items, and a decrease from changes in working capital.
Investing Activities
Investing cash flows generally consist of capital expenditures and cash used for acquisitions. The decrease in cash used for investing activities during fiscal 2020 as compared to fiscal 2019 was primarily the result of a decrease in cash used for capital expenditures.
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Financing Activities
Financing cash flows consist primarily of payments of dividends to stockholders, repurchases of common stock, issuance and repayment of debt, and proceeds from the sale of shares of common stock pursuant to employee equity incentive plans. The decrease in cash used for financing activities during fiscal 2020 as compared to fiscal 2019 was primarily the result of a net increase related to our debt instruments and a decrease in common stock repurchases, partially offset by an increase in dividend payments and a decrease in net proceeds from employee stock plans.
Working Capital
Fiscal Year
2020 2019 $ Change % Change
Accounts receivable, net $ 737,536 $ 635,136 $ 102,400 16 %
Days sales outstanding (1)
45 39
Inventory $ 608,260 $ 609,886 $ (1,626) — %
Days cost of sales in inventory (1)
116 110
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(1) We use the average of the current year and prior year ending net accounts receivable and ending inventory balance in our calculation of days sales outstanding and days cost of sales in inventory, respectively.
The increase in accounts receivable for fiscal 2020 compared to fiscal 2019 was primarily the result of normal variations in the timing of collections and billings.
Inventory in dollars decreased in fiscal 2020 as compared to fiscal 2019, primarily as a result of our efforts to balance manufacturing production, demand and inventory levels. Our inventory levels are impacted by our need to support forecasted sales demand and variations between those forecasts and actual demand.
Current liabilities decreased to $1,365.0 million at October 31, 2020 from $1,508.6 million recorded at the end of fiscal 2019. The decrease was primarily due to decreases in the current portion our debt, partially offset by increases in accrued liabilities.
Revolving Credit Facility
On June 28, 2019, we entered into a second amended and restated revolving credit agreement with Bank of America N.A. as administrative agent and the other banks identified therein as lenders (Revolving Credit Agreement), which further amended and restated our amended and restated revolving credit agreement dated as of September 23, 2016. The Revolving Credit Agreement provides for a five year unsecured revolving credit facility in an aggregate principal amount of up to $1.25 billion, expiring on June 28, 2024. Loans under the Revolving Credit Agreement can be Eurocurrency Rate Loans or Base Rate Loans at our option. Each Eurocurrency Rate Loan will bear interest at a rate per annum equal to the Eurocurrency Rate plus a margin based on our debt ratings from time to time of between 0.690% and 1.375%. Each Base Rate Loan will bear interest at a rate per annum equal to the Base Rate plus a margin based on our debt ratings from time to time of between 0.00% and 0.375%. In December 2018, we borrowed $75.0 million under the previous revolving credit facility and utilized the proceeds for the repayment of existing indebtedness and working capital requirements. We repaid the $75.0 million plus interest of $0.2 million in January 2019. In March 2020, we borrowed $350.0 million under this revolving credit facility and utilized the proceeds for the repayment of existing indebtedness and working capital requirements. We repaid the $350.0 million plus interest of $0.6 million in April 2020.
As of October 31, 2020, we have no outstanding borrowings under the revolving credit facility, but we may borrow in the future and use the proceeds for repayment of existing indebtedness, stock repurchases, acquisitions, capital expenditures, working capital and other lawful corporate purposes. The terms of the Revolving Credit Agreement impose restrictions on our ability to undertake certain transactions, to create certain liens on assets and to incur certain subsidiary indebtedness. In addition, the Revolving Credit Agreement requires us to maintain a consolidated leverage ratio of total consolidated funded debt to consolidated earnings before interest, taxes, depreciation and amortization (EBITDA) for a trailing twelve-month period of not greater than 3.5 to 1.0, assuming we do not undertake any significant acquisitions, mergers, and other fundamental changes. Should such a change occur, we may be authorized to increase the covenant to 4.0 to 1.0. As of October 31, 2020, we were compliant with these covenants. See Note 13, Revolving Credit Facility , of the Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K for further information on our revolving credit facility.
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Debt
As of October 31, 2020, we had $5.1 billion of carrying value outstanding on our debt. The difference in the carrying value of the debt and the principal is due to the unamortized discount and issuance fees on these instruments that will accrete to the face value over the term of the debt. The indentures governing certain of our debt instruments contain covenants that may limit our ability to: incur, create, assume or guarantee any debt or borrowed money secured by a lien upon a principal property; enter into sale and lease-back transactions with respect to a principal property; and consolidate with or merge into, or transfer or lease all or substantially all of our assets to, any other party. As of October 31, 2020, we were compliant with these covenants. See Note 14, Debt , of the Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K for further information on our outstanding debt.
Stock Repurchase Program
Our common stock repurchase program has been in place since August 2004. In the aggregate, our Board of Directors has authorized us to repurchase $8.2 billion of our common stock under the program. Under the program, we may repurchase outstanding shares of our common stock from time to time in the open market and through privately negotiated transactions. Unless terminated earlier by resolution of our Board of Directors, the repurchase program will expire when we have repurchased all shares authorized under the program.
As of October 31, 2020, an additional $1.9 billion remained available for repurchase under the current authorized program. The repurchased shares are held as authorized but unissued shares of common stock. We also repurchase shares in settlement of employee tax withholding obligations due upon the vesting of restricted stock units/awards or the exercise of stock options. In March 2020, we temporarily suspended our share repurchase program as a result of the global macroeconomic environment. That suspension continued through the fourth quarter of fiscal 2020 given the planned acquisition of Maxim. We reinstated the share repurchase program in November 2020 (which is part of the fiscal year ending October 30, 2021). Future repurchases of common stock will be dependent upon our financial position, results of operations, outlook, liquidity, and other factors we deem relevant.
Capital Expenditures
Net additions to property, plant and equipment were $165.7 million in fiscal 2020 and were funded with a combination of cash on hand and cash generated from operations. We expect capital expenditures for fiscal 2021 to be approximately 4% of fiscal 2021 revenue. These capital expenditures will be funded with a combination of cash on hand and cash generated from operations.
Analog Devices Foundation
During the first quarter of fiscal 2020, we contributed 335,654 shares of our common stock to the Analog Devices Foundation. As of the date of the contribution, the shares had a fair value of approximately $40.0 million. This expense was recorded in SMG&A in the Consolidated Statement of Income.
Dividends
On November 23, 2020, our Board of Directors declared a cash dividend of $0.62 per outstanding share of common stock. The dividend will be paid on December 15, 2020 to all shareholders of record at the close of business on December 4, 2020 and is expected to total approximately $229.1 million. We currently expect quarterly dividends to continue in future periods, although they remain subject to determination and declaration by our Board of Directors. The payment of future dividends, if any, will be based on several factors, including our financial performance, outlook and liquidity.
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Contractual Obligations
The table below summarizes our contractual obligations in specified periods as of October 31, 2020:
Payment due by period
Less than More than
(thousands) Total 1 Year 1-3 Years 3-5 Years 5 Years
Contractual obligations:
Transition tax (1)
$ 626,742 $ 59,690 $ 119,380 $ 261,143 $ 186,529
Operating leases ( 2)
380,843 49,526 83,038 74,570 173,709
Other long-term liabilities (3) 69,921 37,131 31,333 87 1,370
Debt obligations (4)
5,175,000 — 1,825,000 950,000 2,400,000
Interest payments associated with debt obligations 1,299,346 161,321 289,731 220,494 627,800
Deferred compensation plan (5)
52,956 801 — — 52,155
Pension funding (6)
6,985 6,985 — — —
Total $ 7,611,793 $ 315,454 $ 2,348,482 $ 1,506,294 $ 3,441,563
_______________________________________
(1) Tax obligation relates to the one-time tax on deemed repatriated earnings under the Tax Cuts and Jobs Act of 2017 enacted in fiscal 2018. See Note 12, Income Taxes , of the Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K for further discussion.
(2) Certain of our operating lease obligations include escalation clauses. These escalating payment requirements are reflected in the table.
(3) Amounts primarily represent future fixed and non-cancellable cash payments associated with software technology and licenses, including the payments due within the next twelve months.
(4) Debt obligations are assumed to be held to maturity.
(5) These payments relate to obligations under our deferred compensation plan. The deferred compensation plan allows certain members of management and other highly-compensated employees and non-employee directors to defer receipt of all or any portion of their compensation. The amount in the “More than 5 Years” column of the table represents the remaining total balance under the deferred compensation plan to be paid to participants who have not terminated employment. Since we cannot reasonably estimate the timing of withdrawals for participants who have not yet terminated employment, we have included the future obligation to these participants in the “More than 5 Years” column of the table.
(6) Our funding policy for our foreign defined benefit plans is consistent with the local requirements of each country. The payment obligations in the table are estimates of our expected contributions to these plans for the current fiscal year. The actual future payments may differ from the amounts presented in the table and reasonable estimates of payments beyond one year are not practical because of potential future changes in variables, such as plan asset performance, interest rates and the rate of increase in compensation levels. As of October 31, 2020, our net liability related to our defined benefit plans was $79.2 million. See Note 11, Retirement Plans , of the Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K for further discussion.
As of October 31, 2020, our total liabilities associated with uncertain tax positions was $24.7 million, which are included in non-current income taxes payable in our Consolidated Balance Sheets contained in Item 8 of this Annual Report on Form 10-K. Due to the complexity associated with our tax uncertainties, we cannot make a reasonably reliable estimate of the period in which we expect to settle the non-current liabilities associated with these uncertain tax positions. Therefore, we have not included these uncertain tax positions in the above contractual obligations table.
The expected timing of payments and the amounts of the obligations discussed above are estimated based on current information available as of October 31, 2020.
Off-balance Sheet Arrangements
As of October 31, 2020, we had no off-balance sheet financing arrangements.
New Accounting Pronouncements
From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (FASB) and are adopted by us as of the specified effective date. Unless otherwise discussed, management believes that the impact of recently issued standards will not have a material impact on our future financial condition and results of operations. See Note 2s, New Accounting Pronouncements, of the Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K for a description of recently issued and adopted accounting pronouncements, including the dates of adoption and impact on our historical financial condition and results of operations.
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Leases
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (ASU 2016-02). ASU 2016-02 requires a lessee to recognize most leases on the balance sheet but recognize expenses on the income statement in a manner similar to historical practice. The update states that a lessee will recognize a lease liability for the obligation to make lease payments and a right-to-use asset for the right to use the underlying assets for the lease term. Leases will continue to be classified as either financing or operating, with classification affecting the recognition, measurement and presentation of expenses and cash flows arising from a lease. The FASB has issued amendments and updates to the new standard, including practical expedients to be used during adoption. The Company adopted the standard in the first quarter of fiscal 2020 under the modified retrospective approach. As a result of the adoption of ASU 2016-02, we changed our accounting policy for leases. See Note 9, Leases , of the Notes to the Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K for details of the impact of this ASU on our financial statements.
Critical Accounting Policies and Estimates
Management’s discussion and analysis of the financial condition and results of operations is based upon the Consolidated Financial Statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, knowledge of current conditions and beliefs of what could occur in the future based on available information. We consider the following accounting policies to be both those most important to the portrayal of our financial condition and those that require the most subjective judgment. If actual results differ significantly from management’s estimates and projections, there could be a material effect on our financial statements. We also have other policies that we consider key accounting policies; however, the application of these policies does not require us to make significant estimates or judgments that are difficult or subjective.
Revenue Recognition
Recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the providing entity expects to be entitled in exchange for those goods or services. As a result of the adoption of new revenue accounting rules in the first quarter of fiscal 2019, we revised our revenue recognition policy. We now recognize revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration that we expect to receive in exchange for those products or services. Under this rule, we recognize revenue when all of the following criteria are met: (1) we have entered into a binding agreement, (2) the performance obligations have been identified, (3) the transaction price to the customer has been determined, (4) the transaction price has been allocated to the performance obligations in the contract, and (5) the performance obligations have been satisfied. The majority of our shipping terms permit us to recognize revenue at point of shipment or delivery. Certain shipping terms require the goods to be through customs or be received by the customer before title passes. In those instances, we defer the revenue recognized until title has passed. Shipping costs are charged to selling, marketing, general and administrative expense as incurred. Sales taxes are excluded from revenue.
Revenue from contracts with the United States government, government prime contractors and certain commercial customers is recorded over time using either units delivered or costs incurred as the measurement basis for progress toward completion. These measures are used to measure results directly and is generally the best measure of progress toward completion in circumstances in which a reliable measure of output can be established. Estimated revenue in excess of amounts billed is reported as unbilled receivables. Contract accounting requires judgment in estimating costs and assumptions related to technical issues and delivery schedule. Contract costs include material, subcontract costs, labor and an allocation of indirect costs. The estimation of costs at completion of a contract is subject to numerous variables involving contract costs and estimates as to the length of time to complete the contract. Changes in contract performance, estimated gross margin, including the impact of final contract settlements, and estimated losses are recognized in the period in which the changes or losses are determined.
Performance Obligations : Substantially all of our contracts with customers contain a single performance obligation, the sale of mixed-signal integrated circuit (IC) products. Such sales represent a single performance obligation because the sale is one type of good or includes multiple goods that are neither capable of being distinct nor separable from the other promises in the contract. This performance obligation is satisfied when control of the product is transferred to the customer, which occurs upon shipment or delivery. Unsatisfied performance obligations primarily represent contracts for products with future delivery dates and with an original expected duration of one year or less. As allowed under ASU 2014-09, we have opted to not disclose the amount of unsatisfied performance obligations as these contracts have original expected durations of less than one year. We generally warrant that our products will meet their published specifications, and that we will repair or replace defective products, for one year from the date title passes from us to the customer. Specific accruals are recorded for known product warranty issues.
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Transaction Price : The transaction price reflects our expectations about the consideration we will be entitled to receive from the customer and may include fixed or variable amounts. Fixed consideration primarily includes sales to direct customers and sales to distributors in which both the sale to the distributor and the sale to the end customer occur within the same reporting period. Variable consideration includes sales in which the amount of consideration that we will receive is unknown as of the end of a reporting period. Such consideration primarily includes credits issued to the distributor due to price protection and sales made to distributors under agreements that allow certain rights of return, referred to as stock rotation. Price protection represents price discounts granted to certain distributors to allow the distributor to earn an appropriate margin on sales negotiated with certain customers and in the event of a price decrease subsequent to the date the product was shipped and billed to the distributor. Stock rotation allows distributors limited levels of returns in order to reduce the amounts of slow-moving, discontinued or obsolete product from their inventory. A liability for distributor credits covering variable consideration is made based on management's estimate of historical experience rates as well as considering economic conditions and contractual terms. To date, actual distributor claims activity has been materially consistent with the provisions we have made based on our historical estimates.
Contract Balances : Accounts receivable represents our unconditional right to receive consideration from our customers. Payments are typically due within 30 to 45 days of invoicing and do not include a significant financing component. To date, there have been no material impairment losses on accounts receivable. There were no material contract assets or contract liabilities recorded on the Consolidated Balance Sheets in any of the periods presented.
Inventory Valuation
We value inventories at the lower of cost (first-in, first-out method) or market. Because of the cyclical nature of the semiconductor industry, changes in inventory levels, obsolescence of technology, and product life cycles, we write down inventories to net realizable value. We employ a variety of methodologies to determine the net realizable value of inventory. While a portion of the calculation is determined via reference to the age of inventory and lower of cost or market calculations, an element of the calculation is subject to significant judgments made by us about future demand for our inventory. If actual demand for our products is less than our estimates, additional adjustments to existing inventories may need to be recorded in future periods. To date, our actual results have not been materially different than our estimates, and we do not expect them to be materially different in the future.
Long-Lived Assets
We review property, plant, and equipment and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value of assets may not be recoverable. Recoverability of these assets is determined by comparison of their carrying value to the estimated future undiscounted cash flows that the assets are expected to generate over their remaining estimated lives. If such assets are considered to be impaired, the impairment to be recognized in earnings equals the amount by which the carrying value of the assets exceeds their fair value determined by either a quoted market price, if any, or a value determined by utilizing a discounted cash flow technique. Although we have recognized no material impairment adjustments related to our property, plant, and equipment and identified intangible assets during the past three fiscal years, except those made in conjunction with restructuring actions, deterioration in our business in the future could lead to such impairment adjustments in future periods. Evaluation of impairment of long-lived assets requires estimates of future operating results that are used in the preparation of the expected future undiscounted cash flows. Actual future operating results and the remaining economic lives of our long-lived assets could differ from the estimates used in assessing the recoverability of these assets. These differences could result in impairment charges, which could have a material adverse impact on our results of operations. In addition, in certain instances, assets may not be impaired but their estimated useful lives may have decreased. In these situations, we amortize the remaining net book values over the revised useful lives.
Goodwill
Goodwill is subject to impairment tests annually or more frequently if events or changes in circumstances suggest that the carrying value of goodwill may not be recoverable, utilizing either the qualitative or quantitative method. We test goodwill for impairment at the reporting unit level, which we determined is consistent with our eight identified operating segments, on an annual basis on the first day of the fourth quarter (on or about August 2) or more frequently if we believe indicators of impairment exist or we reorganize our operating segments or reporting units.
We have the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its net book value. When using the qualitative method, we consider several factors, including the following:
– the amount by which the fair values of each reporting unit exceeded their carrying values as of the date of the most recent quantitative impairment analysis, which indicated there would need to be substantial negative developments in the markets in which these reporting units operate in order for there to be potential impairment;
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– the carrying values of these reporting units as of the assessment date compared to their previously calculated fair values as of the date of the most recent quantitative impairment analysis;
– the current forecasts as compared to the forecasts included in the most recent quantitative impairment analysis;
– public information from competitors and other industry information to determine if there were any significant adverse trends in our competitors' businesses;
– changes in the value of major U.S. stock indices that could suggest declines in overall market stability that could impact the valuation of our reporting units;
– changes in our market capitalization and overall enterprise valuation to determine if there were any significant decreases that could be an indication that the valuation of our reporting units had significantly decreased; and
– whether there had been any significant increases to the weighted-average cost of capital rates for each reporting unit, which could materially lower our prior valuation conclusions under a discounted cash flow approach.
If we elect not to use this option, or we determine that it is more likely than not that the fair value of a reporting unit is less than its net book value, then we perform the quantitative goodwill impairment test. The quantitative goodwill impairment test requires an entity to compare the fair value of a reporting unit with its carrying amount. If fair value is determined to be less than carrying value, an impairment loss is recognized for the amount of the carrying value that exceeds the amount of the reporting unit's fair value, not to exceed the total amount of goodwill allocated to the reporting unit. Additionally, we consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. We determine the fair value of our reporting units using a weighting of the income and market approaches. Under the income approach, we use a discounted cash flow methodology which requires management to make significant estimates and assumptions related to forecasted revenues, gross profit margins, operating income margins, working capital cash flow, perpetual growth rates, and long-term discount rates, among others. For the market approach, we use the guideline public company method. Under this method we utilize information from comparable publicly traded companies with similar operating and investment characteristics as the reporting units, to create valuation multiples that are applied to the operating performance of the reporting unit being tested, in order to obtain their respective fair values. In order to assess the reasonableness of the calculated reporting unit fair values, we reconcile the aggregate fair values of our reporting units determined, as described above, to our total company market capitalization, allowing for a reasonable control premium.
In fiscal 2019, we used the qualitative method of assessing goodwill for seven of our eight reporting units and the quantitative method for one reporting unit. During the second quarter of fiscal 2020, we performed a quantitative assessment of one of our reporting units due to the macroeconomic climate at that time. In our latest annual impairment evaluation that occurred as of August 2, 2020, we elected to use the quantitative method of assessing goodwill for all eight of our reporting units. In all periods presented, we concluded the reporting units' fair values exceeded their carrying amounts as of the assessment dates and no risk of impairment existed.
Business Combinations
Under the acquisition method of accounting, we recognize tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values. We record the excess of the fair value of the purchase consideration over the value of the net assets acquired as goodwill. The accounting for business combinations requires us to make significant estimates and assumptions, especially with respect to intangible assets and the fair value of contingent payment obligations. Critical estimates in valuing purchased technology, customer lists and other identifiable intangible assets include future cash flows that we expect to generate from the acquired assets. If the subsequent actual results and updated projections of the underlying business activity change compared with the assumptions and projections used to develop these values, we could experience impairment charges which could be material. In addition, we have estimated the economic lives of certain acquired assets and these lives are used to calculate depreciation and amortization expense. If our estimates of the economic lives change, depreciation or amortization expenses could be accelerated or slowed.
We record contingent consideration resulting from a business combination at its fair value on the acquisition date. We generally determine the fair value of the contingent consideration using the income approach methodology of valuation. Each reporting period thereafter, we revalue these obligations and record increases or decreases in their fair value as an adjustment to operating expenses within the Consolidated Statements of Income. Changes in the fair value of the contingent consideration can result from changes in assumed discount periods and rates, and from changes pertaining to the achievement of the defined milestones. Significant judgment is employed in determining the appropriateness of these assumptions as of the acquisition date and for each subsequent period. Accordingly, future business and economic conditions, as well as changes in any of the assumptions described above, can materially impact the amount of contingent consideration expense we record in any given period.
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Accounting for Income Taxes
We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of income tax credits, benefits, and deductions, and in the calculation of certain tax assets and liabilities, which arise from differences in the timing of the recognition of certain expenses for tax and financial statement purposes. We assess the likelihood of the realization of deferred tax assets and record a corresponding valuation allowance as necessary if we determine those deferred tax assets may not be realized due to the uncertainty of the timing and amount to be realized of certain state and international tax credit carryovers. In reaching our conclusion, we evaluate certain relevant criteria including the existence of deferred tax liabilities that can be used to realize deferred tax assets, the taxable income in prior carryback years in the impacted state and international jurisdictions that can be used to absorb net operating losses and taxable income in future years. Our judgments regarding future profitability may change due to future market conditions, changes in U.S. or international tax laws and other factors. These changes, if any, may require material adjustments to these deferred tax assets, which may result in an increase or decrease to our income tax provision in future periods.
We account for uncertain tax positions by first determining if it is “more likely than not” that a tax position will be sustained by the appropriate taxing authorities prior to recording any benefit in the financial statements. An uncertain income tax position is not recognized if it has less than a 50% likelihood of being sustained. For those tax positions where it is more likely than not that a tax position will be sustained, we have recorded the largest amount of tax benefit with a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where it is not more likely than not that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements. We classify interest and penalties related to uncertain tax positions within the provision for income taxes line of the Consolidated Statements of Income. We reevaluate these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in known facts or circumstances, changes in tax law, effectively settled issues under audit, and new guidance on legislative interpretations. A change in these factors could result in the recognition of an increase or decrease to our income tax provision, which could materially impact our consolidated financial position and results of operations.
In the ordinary course of global business, there are many transactions and calculations where the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of cost reimbursement and royalty arrangements among related entities. Although we believe our estimates are reasonable, no assurance can be given that the final tax outcome of these matters will not be different than that which is reflected in our historical income tax provisions and income tax liabilities. In the event our assumptions are incorrect, the differences could have a material impact on our income tax provision and operating results in the period in which such determination is made. In addition to the factors described above, our current and expected effective tax rate is based on then-current tax law. Significant changes during the year in enacted tax law could affect these estimates.
See Note 12, Income Taxes , of the Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K for further discussion.
Stock-Based Compensation
Stock-based compensation expense associated with stock options and related awards is recognized in the Consolidated Statements of Income. Determining the amount of stock-based compensation to be recorded requires us to develop estimates to be used in calculating the grant-date fair value of stock options and market-based restricted stock units. We calculate the grant-date fair values of stock options using the Black-Scholes valuation model. The use of valuation models requires us to make estimates of key assumptions such as expected option term and stock price volatility to determine the fair value of a stock option. The estimate of these key assumptions is based on historical information and judgment regarding market factors and trends. We recognize the expense related to equity awards on a straight-line basis over the vesting period. See Note 2r, Stock-based Compensation, and Note 3, Stock-Based Compensation and Shareholders' Equity , of the Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K for more information related to stock-based compensation.
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Contingencies
From time to time, in the ordinary course of business, various claims, charges and litigation are asserted or commenced against us arising from, or related to, among other things, contractual matters, patents, trademarks, personal injury, environmental matters, product liability, insurance coverage, employment or employment benefits. We periodically assess each matter to determine if a contingent liability should be recorded. In making this determination, we may, depending on the nature of the matter, consult with internal and external legal counsel and technical experts. Based on the information we obtain, combined with our judgment regarding all the facts and circumstances of each matter, we determine whether it is probable that a contingent loss may be incurred and whether the amount of such loss can be reasonably estimated. If a loss is probable and reasonably estimable, we record a contingent loss. In determining the amount of a contingent loss, we consider advice received from experts in the specific matter, current status of legal proceedings, settlement negotiations that may be ongoing, prior case history and other factors. If the judgments and estimates made by us are incorrect, we may need to record additional contingent losses that could materially adversely impact our results of operations.
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